Quick, actionable insights for investors
Three rules for turbulent times, Where wages go next, Renewables look set to win in Europe, Opportunities amid inflation
Emotion can overwhelm strategy when markets are volatile. Pendal’s multi-asset chief Michael Blayney has three simple rules to remember in times like these:
Europe is likely to accelerate renewables as a preferred energy solution over “bridge fuels” like gas, says Regnan’s Tim Crockford.
While the humanitarian crisis remains a priority, Europe is sweeping away bottlenecks to reduce dependence on Russian fossil fuels.
What does that mean for “freedom energy” as Germany’s finance minister calls renewables?
“While we’re likely to see a rise in short-term support for fossil fuels, that’s likely to be curtailed by supply and lead-time constraints,” says Tim.
Renewables can be operational sooner than new gas and nuclear capacity, bring countries in line with net zero commitments and are less likely to turn into stranded assets.
“It seems to us that renewables, hydrogen, battery storage and energy efficiency are poised to be the biggest winners.
“This is particularly true for small-scale solar and onshore wind, but even offshore wind has a theoretical lead time of only 18-24 months.” New European gasification infrastructure could take three-to-five years, Tim says.
The latest wage data shows surprisingly modest growth in some sectors.
But wages are the ultimate lagging indicator and that will soon change, says Pendal’s Tim Hext.
The latest WPI data shows the price of labour grew a modest 0.7% in the March quarter and 2.4% for the year.
Those numbers may be surprising especially in industries such as construction and retail which face worker shortages.
But the data will change, since we’ve only fully opened up this year, says Tim.
“The RBA expect the WPI to hit 3% by year end and 3.5% by the end of 2023. Chances are we hit these levels sooner.
“This adds to the narrative that inflation will struggle to fall back to target anytime in the next few years. Investors should still be looking to inflation bonds ahead of nominal bonds.
“Inflation will moderate next year but levels above 3% look like being more entrenched over the next two to three years, helped by wages eventually nearing 4% growth”.
Inflationary periods can be a good time to identify mis-priced stocks if you know what to look for, says Pendal’s Clive Beagles.
Pay attention to the difference between real growth and nominal growth rates of a company, says Clive, a UK-based equity income manager.
Real growth measures are adjusted for inflation. Nominal growth doesn’t adjust for price changes.
“Inflation has meant real growth forecasts have come down somewhat. But companies operate in a nominal growth rate world, and they’re still going to be high.
“Right now in the UK nominal growth could be 10 per cent — and that hasn’t happened since the 1980s.
“It’s a very different environment and people haven’t been focusing on it. Earnings could prove to be much better than people think because they are in nominal terms.”
In all markets it’s important to look at individual companies and decipher the split of revenue growth between inflation and volume, says Clive.
“If you can understand the split, you can identify companies that can pass through price rises, and those that might end up with strong revenue growth but no volume growth.”
Will ESG have a bigger impact at country level after the corporate reaction to Russia’s invasion of Ukraine?
ESG investing has two main aims, says Pendal ESG credit analyst Murray Ackman in our latest podcast.
“One is about avoiding a financial loss or achieving an upside, and the other is about bringing about change.” Can investors bring about change in a country, for instance engaging with sovereign bond issuers?
“You can have a lot of influence over businesses, but countries are a lot bigger and a lot harder to influence, though there have been examples such as South Africa.
“The Russian example is a little idiosyncratic because there’s widespread sanctions and the speed and scale of condemnation in the west is very unique.
“Very few businesses have applied the same standards to other countries that have invaded sovereign nations, though we can see the English Premier League is starting to question this in regard to Saudi Arabia and Yemen, so maybe this will change.
“We’ve seen there is a re-setting of the status quo view, so perhaps this is a watershed moment on the way in which we invest in countries.”
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Inflation, rates and how to think about bonds now, Which sectors look good for global and Aussie equities, How to judge a company’s climate plan
How should investors be thinking about bonds now?
The market is factoring in 3% cash rates and believes we’ll get there around Christmas, says Pendal’s Tim Hext in this podcast.
“I think they’re probably going to end up closer to 2% than 3%, but the point is the market pricing.
“If you buy a bond today, you’re buying the expected interest rates in the future, which are quite high. A 10-year bond is now 3.5%.
“Last time we spoke on this podcast we were heading through 2.5%. I said then, if you’re underweight bonds, you might want to start thinking about getting back to neutral.
“Now they’re starting to get into territory where you could even look at going overweight bonds.
“I believe inflation eventually heads back 2.5% to 3%. And real interest rates – the return you get above inflation – shouldn’t move a lot higher than where they are now, around about 1% for 10 years.
“If you give the government your money today, you’re in a sense locking in an inflation rate around 2.5%, plus an extra 1% return on top, which in my mind for a risk-free asset is quite a good return.”
Rates are rising and long-duration assets like big US tech stocks are underperforming.
Where should investors look?
“The world is normalising and people don’t need as many streaming services,” says Ashley Pittard, Pendal’s head of global equities.
“People aren’t buying as much stuff online. They’re going out again and eating a meal.
“That’s why in the current earnings season in the US we’ve seen Amazon and Netflix disappoint but Coca-Cola’s numbers were fantastic.
“Coca-Cola is in a duopoly market and it’s got pricing power. In an inflationary environment, that’s what you want.
“Covid brought forward demand for many tech products. There are supply chain problems and higher input prices.
“And rising interest rates hurt long-duration assets because the discount rate applying to future cash flows increases.”
Be wary of the FAANGs and look for companies that can move prices with inflation, says Ashley.
As the US Fed lifts rates, conventional wisdom says EM economies must keep pace to avoid capital outflows, putting a dampener on their economies.
But this time might be different, says Pendal’s James Syme.
“Our view is that EMs have been hiking hard for some time now — and it actually looks like it’s the Fed that is significantly behind the curve.”
For example, Brazil’s central bank has raised policy interest rates nine times since the first post-pandemic hike in March 2021.
“The implication is that if the Fed has to do 400 basis points in hikes, that doesn’t mean Brazil is going to have to.” The story is similar in South Africa and Mexico, says James.
There’s still a question as to why the Fed is moving more slowly than emerging markets.
“Maybe the Fed is right — maybe there’s much more deflation coming than we can see in trailing data.
“But if that’s the case, we could be getting to the top of EM interest rate cycles. If that’s true, maybe we can start cutting rates again.”
“Investors need to have confidence that climate risks are being managed well by companies in their portfolios,” says Regnan’s head of research Alison George.
But how can you tell? It’s a complex question, but Alison offers a four-point checklist.
Is the plan credible? Does it comprehensively cover material issues? Is it clearly disclosed, with sources? Does it broadly consider the impact of the net zero transition?
Is it ambitious? You should see clear, comprehensive targets in the short, medium and long term on all material aspects of climate change, including value chain emissions and physical risks.
Is it real? Is it backed by enough resourcing and capability, appropriate organisational structure, cap-ex plans and effective board oversight? Has the plan informed strategy development and decision-making? Is there evidence of progress?
Are they acting against change? Is the company paying lip-service while lobbying against change?
A company that passes all four tests is likely to have a solid climate action plan.
Aussie equity investors will have noticed a large sector divergence in the ASX300 this year. Our head of equities Crispin Murray rates the sectors from best-performed to worst:
Right now the issue weighing on markets is not so much the rate hikes — which have been well flagged — but widespread scepticism that central banks can tame inflation without causing recession, says Crispin.
How to think about cash right now, China’s impact on fixed interest and global equities, a critical juncture for Aussie equities
“There really is no obvious default for investors in this kind of market,” says Brenton Saunders, who manages Pendal Midcap Fund.
“With macro factors lurching around so quickly, it pays to have a very balanced portfolio.
“Things that once took a year to play out are happening inside a quarter. If you have big macro tilts in your portfolio, you run a big risk of getting it wrong at some stage if you’re not nimble enough.
“We’ve seen an extension of the de-rating of high-multiple, high-growth sectors. We’re now seeing cyclical stocks like commodities getting impacted as well.”
A sensible positioning is to stay conservative, pragmatic and style-agnostic, says Brenton.
“It’s very much a stock-picker’s market. It is really now about understanding a company’s specifics and spending time with a company.
“Even subtle differences in terms of exposures in cost and revenue bases can create quite different outcomes in similar-looking companies.
“It is an environment where research and stock picking are making a difference.”
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